ExpertMedium2 marksMultiple Choice
ACCA · Question 26 · Risk Management
Section B - Case 3: GlobalLogix
Scenario: GlobalLogix is a cross-border logistics firm based in the Eurozone (€). The company expects to receive $2,000,000 from a US client in 3 months' time.
Current spot rate ($/€): 1.1500 - 1.1550
3-month forward rate ($/€): 1.1600 - 1.1660
Eurozone interest rates: Borrow 2.0% per year, Deposit 1.0% per year.
US interest rates: Borrow 4.0% per year, Deposit 3.0% per year.
If GlobalLogix uses a forward contract to hedge this receipt, how many Euros (€) will they receive in 3 months?
Section B - Case 3: GlobalLogix
Scenario: GlobalLogix is a cross-border logistics firm based in the Eurozone (€). The company expects to receive $2,000,000 from a US client in 3 months' time.
Current spot rate ($/€): 1.1500 - 1.1550
3-month forward rate ($/€): 1.1600 - 1.1660
Eurozone interest rates: Borrow 2.0% per year, Deposit 1.0% per year.
US interest rates: Borrow 4.0% per year, Deposit 3.0% per year.
If GlobalLogix uses a forward contract to hedge this receipt, how many Euros (€) will they receive in 3 months?
Answer options:
A.
€1,739,130
B.
€1,724,138
C.
€1,715,266
D.
€2,332,000
How to approach this question
Identify the base currency and the transaction. The quote is $/€ (indirect quote for a Eurozone company). GlobalLogix receives $, so they must sell $ to the bank. The bank will give them the worst rate (the higher number in an indirect quote). Divide $2m by 1.1660.
Full Answer
C.€1,715,266✓ Correct
GlobalLogix is based in the Eurozone, so € is their home currency. They are receiving $2,000,000. They need to sell these dollars to the bank in exchange for Euros.
The exchange rate is quoted as $/€ (Dollars per 1 Euro).
To convert $ to €, we divide.
The bank will apply the rate that gives GlobalLogix the fewest Euros (the bank always wins). Therefore, we divide by the higher rate in the forward spread: 1.1660.
$2,000,000 / 1.1660 = €1,715,265.87.
Common mistakes
Using the wrong side of the spread (1.1600) or multiplying instead of dividing.
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